Question

J&L Packaging, Inc.: Cash-to-Cash Conversion Cycle Case Study

Jake and Lilly Gifford founded J&L Packaging, Inc. (J&LP) in 1995 after graduating from the University of Cincinnati. Jake earned a degree in robotics and mechanical engineering, while Lilly graduated with a degree in computer science. They met at the university while working on an information systems course project and married immediately after graduation. Their privately held firm manufactured cardboard packaging and boxes for computer devices such as personal computers, keyboards, replacement hard drives, servers, and so on. Many of their packages were high-end boxes with glossy finishes and the company’s logo on the box. Last year, J&L Packaging, Inc. sales were $106 million.

J&LP Packaging provided many services with their products, such as box and packaging design engineering and consulting, embossing and foil guidance, barcode advice, cartons that fold and collapse for easy storage, and a variety of colors and box strengths. In 2010, J&LP began to research the sustainability issues regarding boxes in the reverse logistics supply chain.Their research lead to a change in production technologies to accommodate up to 100 percent recycled fiber content and solar panels on the roofs of their two U.S. factories. They also hired an engineer to lead the company’s efforts to become a “Green Cycle”-certified manufacturer.

J&LP recently purchased and installed an ISOWA FALCON state-of-the-art, four-color, high-speed flexo box machine with an extensive zero defects quality control system. This box cutting and fabrication machine is manufactured in Kasugai, Japan, by the ISOWA Corporation (www.isowa.com). There are several videos of this automated machine in operation on YouTube,” for example https://www.youtube.com/watch?v5XofTns666Aw.

J&LP’s financial information for last year follows. It is assumed the business operates 300 days per year. One note in J&LP financial statement states that the $4,906,000 of inventory does not include $886,000 in inventory allowances for excess, cancelled orders, and obsolete inventories. The note goes on to say, “Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times versus the risk of inventory obsolescence because of changing technology and customer requirements. The box and packaging business is a dynamic industry that must quickly accommodate customer requirements, changes in forecasts, and new findings from research and development on product features and options.” The following data (in thousands of dollars $) is provided.

Sales
• Manufactured Goods	$87,475
• Services	$18,619
• Total	$106,094
Cost of Sales
• Manufactured Goods	$25,818
• Services	$ 5,907
• Total	$31,725
Operating Expenses
• Research and Development	$17,619
• Sales and Marketing	$23,132
• Other	$ 6,182
• Total	$46,933
Obsolete Inventories	$ 886
Inventories	$ 4,906
Accounts Receivable	$ 7,593
Accounts Payable	$ 9,338

1. Should we consider services in the cash-to-cash conversion cycle computations?
2. How will you handle the $886,000 in obsolete inventory?
3. What is the total cash-to-cash conversion cycle for J&L Packaging, Inc. for last year?
4. What are your conclusions and final recommendations?

I do not want someone to simply answer the questions for me. I want to make sure I am doing it correctly.

Specifically, I would like help with question #3

The formula provided for cash-to-conversion is:

ARDS= Accounts receivable value/Revenue per day

APDS=Accounts payable value/Revenue per day

Revenue per day (R/D) =Total revenue/Operating days per year

Cash-to-cash conversion cycle =IDS+ARDS-APDS

Here's what I got:

Inventory days’ supply (IDS) =

Average total inventory/ Cost of goods sold per day=4,906+886=5792

Cost of goods sold per day (CGS/D) = 31,725/300 Days per year= 105.75

Cost of goods sold value/ Operating days per year

5792/105.75=54.77

IDS=54.77

IDS+ARDS= the firms receivable cycle is 80.08

ARDS= Accounts receivable value/ Revenue per day =7,593/300=25.31

APDS= Accounts payable value/ Revenue per day =9,338/300=31.13

APDS =31.13, which is how many days the firm has to pay back its bill.

Which means the firm receives it payments, “receivables” 48.95 days later.

Is this right? Help!

Answer 1

Should we consider services in the cash-to-cash conversion cycle computations?

No. we cannot consider services in the cash-to-cash conversion cycle because the computation involves converting the cash required in buying the raw materials for the inputs and time required to convert the cash back to its form once the inventories are converted into accounts receivable and subsequently, the accounts receivable converted back to cash again for the firm.

Therefore, it is an efficiency ratio that determines the number of days required by the firm to convert cash back to its form from inventories and accounts receivable. Therefore cash for the inventory being the underlying object for the computation, services cannot fit it the same for computations because there is no concept of waiting period involved converting the cash into services and services back to accounts receivable and then into cash.

How will you handle the $886,000 in obsolete inventory?

It is poor planning to have $886,000 in obsolete inventory, before taking any action it is always better to find what lead to this situation. Finding root cause and acting is better. Now there are many ways to deal with obsolete inventory which are mentioned below.

1. Talk to vendor and return: If vendor is ready to take back part or full inventory, it is better to return. It is always good to have return policy with vendor.
2. Second sales: If vendor is not ready to take back product, it is better to do second sales. Auctioning the obsolete inventory might help in reducing losses, even through losses cannot be recovered full.
3. Scrap: If product cannot be sold in second sales, then scrap the product and sale. Many items in the product might be useful to produce new product.
4. Discount sale: one can also give deep discount to sell the product. This helps in recovering some losses.
5. Liquidate: If no other alternative is available, then Liquidate.

What is the total cash-to-cash conversion cycle for J&I. Packaging, Inc. for last year?

The cash-to-cash conversion cycle is computed as inventory days' supply (IDS) plus accounts receivable days' supply (ARDS) minus accounts payable days' supply (APDS).

Note the following relevant formulae:

Inventory days’ supply (IDS) = -----------------------(1)

Accounts receivable days’ supply (ARDS) = --------(2)

Accounts payable days’ supply (APDS) = --------------(3)

Given,

Average inventory = $4,906,000

Total accounts receivables = $7,593,000

Total accounts payables = $9,338,000

Total sales = $106,094,000

Total cost of goods sold = $31,725,000

Number of days per year = 300

From (1), IDS =

From (2), ARDS =

From (3), APDS =

So, the cash-to-cash conversion cycle is = IDS + ARDS – APDS

.

What are your conclusions and final recommendations?

The cash-to-cash cycle for combined goods and service is found to be 41.46 days which definitely have scope to reduce. The largest contributor to this value is the Inventory days’ supply (IDS) which is 46.39 days.

Recommendations

1. The company should reduce the average inventory level. This can be done by implementing a postponement strategy which keeps the differentiated part of the process to the end of the value chain and keeps the inventory for generic parts. The company can keep the inventory of generic packaging materials and can modify or alter the same after receiving the customer orders. This will substantially reduce the inventory cost.

2. The accounts receivable days’ supply is more than 21 days as of now. This can be reduced by negotiating with the customer or providing the customers with discounts which may be available with an early payment.

These two alternatives will reduce the IDS and ARDS substantially and will reduce the C2C convention cycle time.